Geopolitical Developments: Chinese Risks Are Mounting And Equity Markets Are Showing It

Risks are growing that China’s leadership has lost its way and pulling not just their country down but the global economy that depends so much on it. Equity markets staged an unimpressive rally yesterday after falling to my target level, and the elevated levels of volatility point to rising uncertainty about the global economic order. The volatility risk premium points to a higher market over the next few days, but my technical reading of key stocks in the S&P 500 is bearish. Yesterday's cross-asset action brought one positive factor for US stocks. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there were also several negative factors across global asset classes. Copper is pointing to declining global GDP expectations. The US yield curve is rising and in the current context that is bearish. Expect the S&P 500 to fall over the next few days.

It’s rare that currency markets express the political divide between nations, but that is what’s happening present-day China, where Yuan’s depreciation is a vote against Xi Jinping’s regime and in support of the American system of openness and individualism. The yuan has lost 5% of its value in a month, a dramatic sell-off that’s the opposite of the Chinese Communist Party propaganda about stability and prudent economic management by Big Brother. Currency traders are betting China fails miserably to hit its economic targets because of its moronic COVID policies and its policy reversals regarding debt and infrastructure spending. This becomes a self-fulfilling prophesy and a can’t lose proposition for currency traders because the Yuan’s dramatic depreciation lowers confidence and catalyzes capital flight, which the CCP cannot fully control, amplifying policy mistakes and making a hard landing all but guaranteed. Affluent Chinese will be infuriated since they can no longer look to Hong Kong as a safe place to park their wealth, but now have to risk the wrath of the Party and try getting their money out even if they can’t board a plane to get themselves out.

Reuters notes “However, unlike 2018-19, when the yuan fell through the U.S.-China trade war, or 2015-16, when a domestic stampede to offshore assets accelerated a decline, investors and analysts say that foreign selling is now the dominant driver, presenting new downside risks…Combined with increasing tailwinds for the U.S. dollar, these risks could lead to further yuan weakness with the People's Bank of China unable or less inclined to restrict global capital movement…"I don't think the renminbi is weakening because (authorities) want to support exports," said Alicia Garcia Herrero, Asia Pacific chief economist at Natixis, referring to the currency by its official name. “I think the renminbi pressure is coming from investors leaving and a loss of confidence in the economy," she said.”

Proof that the CCP is caught in a doom loop is the frustration and high-handedness seen in Shanghai and increasingly across the country. One flamboyant example of autocratic insecurity is reported by CNN: “Chinese social media have shut down the accounts of a prominent market analyst who drew attention in recent weeks to the dramatic slowdown in the country's economy and the effects of government policy on the tech industry…Over the weekend, Tencent's (TCEHY) WeChat froze the public account of Hong Hao, managing director and head of research at BOCOM International, the investment banking arm of Bank of Communications, a state-owned bank and China's fifth largest. The move came after he posted about huge outflows of capital from the country and made bearish forecasts about the Chinese stock market on social media.”

Global investors are starting to worry that China could now become a drag on the world economy, should Xi Jinping continue to pull away from the rest of the world and destroy basic liberties while locking down the nation. Earnings estimates are on the way down but have much further to do in such a scenario, and I see markets discounting that possibility as we make new lows through the month.

My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO.